Directors and officers need to regularly consider the risks involve and take action to avoid breaching their duties.
ESG factors, such as physical, transitional and social risks have increasingly become more of a concern for insurers in the current market. For example, flooding events are considered to be the most significant climate-related risk to insurers in the current era. This is demonstrated by the fact that, since the 1980's, the number of registered weather-related loss events has tripled and as a resulting factor amongst other loss events, inflation-adjusted insurance losses have increased by more than £35 billion from around £7.8 billion in the 1980 to around £43 billion in the last decade1. Added to this are transitional risks, which are driven by the move towards a decarbonised economy, meaning that insurers that have investments in companies associated with high priority climate factors such as fossil fuels, may see a decline in the value of their assets as we start to see a shift towards more renewable energy sources due to new environmental regulations. Insurers' investment portfolios may also start to be affected by social risk factors, such as human rights violations, as these investments do not align with ESG principles and are considered to be unsustainable in the modern era.
In order to help insurers manage ESG risks, a number of advisory bodies have been set up and focus on providing guidance on financial risks. One of these institutions was the Task Force on Climate-related Financial Disclosures (TCFD), which was set up to help address concerns raised around insufficient disclosure of climate-related risks. Established by the G20, the Task Force wanted companies to move away from what they consider to be the 'traditional backward-looking sustainability focused lens' and instead towards a forward-looking financially focused view. This would require companies to move climate-related disclosures from standalone sustainability reports and instead into mainstream reports (the annual package of information that certain companies are required to produce by law). The aim of doing this was to make the climate-related disclosures more consistent and therefore be able to be compared between companies. In 2017, in order to achieve their objective, the Task Force developed and released a reporting framework which was based on a number of consistent disclosure recommendations intended to provide transparency about a company's climate-related risk exposures. The framework focused on four areas: Governance, Strategy, Risk Management and Metrics & Targets. The four areas were then supported by 11 recommended disclosures, which aimed to support companies and provide guidance on what information they should provide to investors and consumers about their climate-related risks.
Governance
| Recommended disclosure | Guidance for insurers |
| Describe the Board's oversight of climate-related risks and opportunities. | Look at how Board's competence in
understanding and managing the climate risks & opportunities is
managed, and how frequently the Board are informed about
climate-related issues. Look at whether the Board considers and reviews climate-related risks in relation to budgets, risk management policies, etc. |
| Describe Management's role in assessing and managing climate-related risks and opportunities. | Think about whether there are any climate-related committees set up or if the company has a management level position responsible and accountable to manage these risks. |
Strategy
| Recommended disclosure | Guidance for insurers |
| Describe the climate-related risks and opportunities the
organisation has identified over the short, medium, and long term. |
Consider the companies short, medium and long term opportunities and how these may have an impact on the company, including a financial impact. |
| Describe the impact of climate-related risks and opportunities on the organisation's businesses, strategy, and financial planning. | As well as describing the impacts, provide quantitative information (where available) in relation to your core business, products and services. |
| Describe the resilience of the organisation's strategy,
taking into consideration different climate related scenarios,
including a 2°C or lower scenario. |
This is in relation to your underwriting activities and should include critical input parameters, assumptions and considerations, as well as time frames for short, medium and long term targets. |
Risk Management
| Recommended disclosure | Guidance for insurers |
| Describe the organisation's processes for identifying and assessing climate related risks. | Within your description, consider the risks on insurance portfolios by geography, division or product segment. |
| Describe the organisation's processes for managing climate related risks. |
Include things like risk models in relation to product development or pricing. |
| Describe how processes for identifying, assessing, and managing climate related risks are integrated into the organisation's overall risk management. | Climate risks & opportunities should not be managed in silos, instead they are to be integrated into the core risk management and assurance processes. |
Metrics & Targets
| Recommended disclosure | Guidance for insurers |
| Disclose the metrics used by the organisation to assess
climate-related risks and opportunities in line with its strategy and risk management process. |
Look at whether consideration has been given to expected losses from weather-related issues and also describe how your underwriting activities are aligned with the Paris Climate Agreement. |
| Disclose Scope 1, Scope 2, and, if appropriate, Scope 3 greenhouse gas (GHG) emissions, and the related risks. | This should include (if possible) weighted average carbon intensity or GHG emissions associated with commercial property and speciality strands of the company. |
| Describe the targets used by the organisation to manage climate
related risks and opportunities and performance against targets. |
Look at targets in relation to GHG emissions, energy usage/waste. Look at the time frames of the targets included and how these are assessed and against what baseline year. |
Litigation in relation to ESG factors has been on the rise over the
last decade, with a number of high-profile cases entering the court
systems across the world in an attempt to bring action against
companies and governments that are alleged to have a detrimental
impact on the environmental, social and governance principles. An
area with a high focus rate is climate change litigation, where,
since December 2022, there have been 2180 climate-related cases
filed in 65 jurisdictions , an increase from 884 and 1550 in 2017
and 2020 . One of the highest profile cases is Milieudefensie v.
Shell (2021), in which the Dutch branch of Friends of the Earth and
other non-governmental organisations asked the court to:
- Rule that the Shell groups' annual Co2 emissions and Royal Dutch Shell's failure to reduce them, constituted an unlawful act towards them.
- 2. Order that Royal Dutch Shell must reduce the Shell groups' Co2 emissions by 45% by the end of 2030 in comparison with 2019 levels.
The groups' main argument was that Royal Dutch Shell, as the top holding company who had responsibility for setting Shell Group's corporate strategy, owed a duty of care under the Dutch Civil Code that required them to take appropriate steps to ensure they were in line with the 1.5 degree cap agreed under the Paris Climate Agreement (for your information, the Paris Climate Agreement is a legally binding treaty adopted in 2015 at COP21 aimed at limiting the global temperature increase to 1.5°C above pre-industrial levels). Based on the evidence provided, the court ordered Shell to reduce its Global Carbon Emissions by 45% by the end of 2030 in comparison with 2019 levels. These emissions were not limited to just operational emissions but also the emissions produced from the products Shell sells. The ruling by the court was considered to be the first major climate change litigation ruling against a company.
Away from environmental and climate change litigation, there has also been a significant increase in litigation in regard to social factors including human rights violation. A high profile matter is the US v Lafarge (2022) in which the US Justice Department brought a case against French cement maker Lafarge and its Syrian subsidiary in regard to conspiring to provide material support and resources in Northern Syria to the Islamic State of Iraq (ISIS). The US Justice Department stated that Lafarge negotiated agreements to pay armed factions in the civil war to protect their employees and ensure that operation at their cement plant could continue, as well as obtain an economic advantage over their competitors in the Syrian cement market. The payments were in the region of nearly $6 million and helped the company do $70.3m in sales. Emails submitted as evidence demonstrated that Lafarge executives made clear in contemporaneous emails that their motives were primarily economic. Lafarge pleaded guilty and had to pay financial penalties, including criminal fines and forfeiture totalling $777.78 million. As a result of the guilty plea, on 14 December 2023, hundreds of Yazidi-Americans filed a lawsuit against Lafarge for aiding and abetting terrorism conducted by the Islamic State of Iraq and Syria (ISIS) against the Yazidi population. The lawsuit, which is led by Nobel Prize winner and human rights activist Nadia Murad, aims to hold Lafarge accountable for its admitted criminal conspiracy with ISIS.
Further examples of litigation involving ESG factors include:
| Kivalina v ExxonMobil (2009) | A claim was brought against 24 oil, energy and utility companies by a number of individuals who lived on the Alaskan Island of Kivalina, on the basis that their island was facing extreme erosion and weather events due to climate change in which the energy companies were the main contributing factor and relocation of the residents would cost between $95 million and $400 million. The claim was dismissed, as the court considered that the question of how best to address climate change was a political question not appropriate for a court to decide. It further stated that the individuals could not demonstrate that the energy companies had caused them injury. |
| Duarte Agostinho and Others v Portugal and 32 Other States (2020) | Six Portuguese youths aged between 11 and 24, filed a complaint with the European Court of Human Rights against 33 European countries on the basis that their human rights had been violated due to insufficient action being taken on climate change. The complaint is in relation to Article 2 (right to life), Article 8 (right to privacy) and Article 14 (right to not experience discrimination) of the European Convention on Human Rights. The argument raised is that their rights are affected due to the effects of climate change such as forest fires, their physical and mental wellbeing has suffered due to heatwaves forcing them to spend more time indoors and finally, as young people, they stand to experience the worst effects of climate change. The youths are seeking an order that requires each country to take more ambitious action which is in line with the Paris Climate Agreement. The claim is ongoing. |
| Okpabi et al vs Royal Dutch Shell et al (2015) | In 2015, thousands of people from the Ogale and Bille communities of the Niger Delta began legal action against Shell in the UK. They alleged that Shell caused serious harm to their human rights and well-being due to chronic oil pollution of their water sources and destruction of their way of life. The matter has been in the courts for nearly 10 years as the High Court in London originally held that Royal Dutch Shell is merely a holding company which does not exercise any control over the operations of its Nigerian subsidiary and on this basis, does not have a duty of care to the claimants and their communities. The Court of Appeal in 2018 further stated that the English courts do not have jurisdiction over the claims. Finally, in 2021, the Supreme Court ruled that it was arguable the pollution had fundamentally breached the villagers right to a clean environment under the Nigerian constitution and the African chart on human and people's rights. This decision entitled more than 13,000 farmers and fishers to bring a claim for alleged breaches to their right to a clean environment. The claim is ongoing. |
As well as ESG litigation risks to the company, directors and
officers (D&O's) need to make sure that they are aware of
ESG as a risk to governance frameworks and operational performance.
For example, D&O's need to be aware and adapt their
governance practices in order to meet evolving regulatory standards
and expectations, as well as identify any risks that may cause
operational disruptions. Failure to do so may result in loss of
reputation, as consumers in the modern era are now more likely to
choose a company that aligns with their ESG beliefs. As a result of
this, the company faces financial risks as consumers would be less
likely to choose their companies' services compared to their
competitors who may have more friendly ESG policies. Alongside
consumer expectations are shareholder and stakeholder expectations,
who are now becoming more vocal on ESG policies. This is resulting
in companies enforcing changes to their policies and practices to
reflect good ESG practice. In light of this, the pressure faced by
D&O's to align with ESG objectives may cause governance
challenges which they will then have to spend time to appropriately
manage. D&O's must also ensure that they have in place
adequate operational resilience planning, as failure to react to
potential disruptions caused by climate events and regulatory
changes previously mentioned, may cause disruptions to business.
D&O's must ensure that they have plans in place that will
allow for business to continue effectively in these events.
D&O's also face challenges in relation to shareholder or derivative actions under section 90 & 90A of the Financial Services and Markets Act 2000 (FSMA). Section 90 relates to particulars (a document that must be published in certain circumstances under the UK listed authority rules when securities are issued), whilst section 90A relates to the loss to any person as a result of misleading information provided by a company. This misleading information can be as part of a company's disclosure statement. Under both sections, companies must ensure that any disclosures in relation to ESG are accurate, in order to avoid claims that they are misleading. Potential claims could arise from companies providing misleading or incorrect information on their net-zero polices in order to influence potential consumers against other competitors. Similarly, false ESG claims may cause a company's stock value to rise and be considered market manipulation, resulting in action being taken under FSMA. D&O's need to be extra vigilant when making ESG claims as part of their reporting requirements, in order to ensure that they do not create misrepresentations, as action can be taken whether they were intentional or not.
D&O's also need to be aware of their duties set out under 172 & 174 of the Companies Act 2006, as although they do not both specifically mention ESG risks, they still may be at risk of breaching their duties should they fail to consider ESG issues that have the potential to affect a company's financial performance, operation or reputation. Section 172 imposes a duty to "act in a way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole". Section 174 imposes a duty to "exercise reasonable care, skill and diligence". D&O's are likely required to consider the long term consequences of any decisions made that may impact the environment and local communities. It is therefore extremely important that D&O's are aware of the ESG risks that could result in them breaching their duties, such as their companies' failure to comply with environmental regulations and failure to take into account their social responsibilities. For example, D&O's must ensure that the company is prepared and compliant for when new regulations are introduced, as well as making sure ethical standards are established to ensure that ethical underwriting practices are adhered to.
With the constant updating of regulations and increasing frequency of litigation in relation to ESG factors, D&O's need to regularly consider the risks involve and take action to avoid breaching their duties. Failure to do so will not just result in possible penalties for their company but may result in further financial losses due to reputational damage and a swing in consumer priorities.
Footnotes
1. Munich Re NatCatSERVICE statistics as at end 2017. (from this report - https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/report/transition-in-thinking-the-impact-of-climate-change-on-the-uk-banking-sector.pdf )
1. Global Climate Litigation Report: 2023 Status Review - https://www.unep.org/resources/report/global-climate-litigation-report-2023-status-review#:~:text=As%20of%20December%202022%2C%20there,United%20Nations%20and%20arbitration%20tribunals.
1. Global Climate Litigation Report: 2023 Status Review - https://www.unep.org/resources/report/global-climate-litigation-report-2023-status-review#:~:text=As%20of%20December%202022%2C%20there,United%20Nations%20and%20arbitration%20tribunals.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
